James Ashton: China now knows it has to change its controlling ways

Cash is still king: China has to revalue the renminbi and relax lending requirements to boost the economy

For a decade or more, the one-word answer to reviving the global economy has been China. Other emerging Bric nations fell away but China was reliable, robotic even, in its ability to punch out a 10 per cent growth rate year in, year out when developed countries such as the UK would pat themselves on the back for achieving a third of that.

Of course China started small and had decades of industrialisation to catch up on. It has well-chronicled failings such as smoggy air and a questionable human rights record but its development plan has been a single-minded success. New cities have emerged from the ether, Chinese corporations have learnt to compete head-on in cut-throat industries such as consumer electronics and millions of inhabitants have been lifted out of poverty and are heading towards middle-class status.

Today China is the world’s second-largest economy behind the US and accounts for close to 15 per cent of global GDP. When the global recession hit in 2008, it took the strain as the world’s construction site and carried on gobbling up the available metals supply.

So this week’s stock-market gyrations, driven by fear over weakness in China’s economy, take some comprehending. There are two concerns. Firstly, that China, the solution for exporting countries suffering from weak demand at home, has become part of a new problem. Can the economic miracle of our times really just be another boom-and-bust nation? The second concern is that Chinese government efforts to stabilise the situation were inconclusive. One of the most controlling countries in the world is struggling to get a grip.

The precipitous fall in the FTSE 100 demonstrates that China’s problem is not an overnight sensation. The blue-chip index, full of mining companies which rely on China as their best customer, has slid from more than 7,000 points to less than 6,000 in three months. In the depths of August, markets don’t know which way to turn. Volumes are low and traders are getting skittish — which drives up volatility.

What feeds the uncertainty is a lack of consensus. There is a clear division between those who believe China is over the worst of a wobble and those who view this week as the tip of the iceberg. It is a debate between long-term prospects versus short-term troubles.

Advertising tycoon Sir Martin Sorrell came out strongly in favour of the former yesterday, describing himself as a “raging bull” in relation to China, putting recent events into the context of 30 years of strong growth.

It is true that China still holds great appeal. The forecast seven per cent growth this year might be the slowest rate since 1990 — and could yet be far less. But it is still solid growth. And the diversification of an economy from one fuelled by construction activity to one that consumes more sophisticated services is not without bumps on the way.

There is still plenty of benefit of the doubt out there. Some market watchers raise the notion that China’s “real” performance is masked because the statistics it measures are outdated. Investment banks view this week’s sell-off as a huge buying opportunity.

However, hopes of a golden future have been clouded by concerns for some time. The International Monetary Fund warned last year of the impact of rising debt levels in a handful of nations, including China, and of the banking crisis that could lie ahead.

The fear is that an economy built on borrowing cannot be sustained. Coming from Europe, does that sound familiar? Investors worry about a housing bubble that has seen expensive high-rises built that no one is ever going to live in, that the Chinese consumer is overstretched. As we know from Europe’s own credit crisis, all sorts of nasties become exposed when the tide goes out.

Couple that with China’s lethargy to act. Efforts to prop up a plunging stock market last month were confidently introduced then abandoned. Then came the late entry to the global currency war with the devaluation of the renminbi, a move that prime minister Li Keqiang had previously been cool on. Then, finally, China injected $100 billion into its financial system via a rate cut to top up liquidity. It also relaxed lending requirements, perhaps not ideal in an economy that is struggling with too much debt.

The question is: where will it end? China’s trade deficit has created huge foreign reserves, a buffer that should shore it up against any troubles, but there are doubts that even that bazooka might not be enough if confidence drains away.

After Monday’s sell-off, Wall Street closed on a sounder footing last night, helped by some soothing comments from William Dudley, head of the New York branch of the Federal Reserve.

As well as taking next month’s hoped-for interest rate rise off the agenda, Dudley talked about the downside risk to US economic growth but insisted that these current problems were predominantly Chinese.

That is partly true: if the world’s growth engine splutters to a halt it is hard to see how anyone will escape unscathed. But in the short term there are benefits from a slowing China for the UK: cheaper imports, low interest rates and cheap oil.

It is worth remembering that two years ago China used the US public sector shutdown and impending budget crisis to call for the “de-Americanising” of the global economy. What a good job it has so far not succeeded.

What is clear from this week’s episode is that China must itself reform. If it is to see off these growing pains and a future crisis there will have to be less state control of the economy, a freely-floating currency and more wealth put in the pockets of Chinese consumers. It is a tall order for a country used to having its own way. Stand by for more market turmoil.